FOREX-Dollar claws back some ground lost on Fed's dovish tone

* Greenback higher vs euro after biggest fall in six years

* Fed’s statement far less hawkish than market expected

* USD seen as vulnerable to further correction

By Lisa Twaronite and Ian Chua

TOKYO/SYDNEY, March 19 (Reuters) – The dollar steadied on Thursday, rising off lows hit overnight after the Federal Reserve struck a much more dovish than expected tone on interest rates.

The Fed dropped the word “patient” from its statement in terms of raising interest rates, as expected, but also downgraded its views on the economy and inflation and lowered its interest rate trajectory. That signalled a far more gradual path to policy normalisation than many investors had foreseen.

Fed Chair Janet Yellen, who like most central bankers tends to avoid discussing currencies, told reporters the strong dollar is compressing inflation “at least on a transitory basis,” which suggests a tacit admission that the soaring dollar had stalled the central bank’s policy-tightening plan.

“Most people think the Fed looks very dovish, and might start to hike not in June, but maybe in September or October,” said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo.

“Yellen wants to get a free hand in the timing of hiking rates,” he said.

In the wake of the Fed’s revelation, U.S. Treasury yields dived and Fed funds futures surged. The dollar index skidded, retreating from a 12-year peak set on Friday. It was last down 0.4 percent on the day at 98.187.

The euro bounced as high as $ 1.1062 on Wednesday on the Fed’s announcement, its biggest one-day rise against the dollar in six years and moving well off a 12-year trough of $ 1.0457 plumbed on Monday. But some of those gains unravelled and it last stood at $ 1.0783, down about 0.7 percent on the day.

“Our technical analysts now say we are looking at a bullish short-term trend reversal in EUR/USD that opens up $ 1.1016 and $ 1.1098 on the topside,” said Elsa Lignos, senior currency strategist at RBC Capital Markets.

“But fundamentally we like layering into a EUR/USD short and adding to the position between $ 1.1050 and $ 1.11, targeting an eventual move to parity.”

Still, the sharp dollar selloff dealt a severe blow to the confidence of many dollar bulls. Some market participants said strong U.S. data was needed for sentiment to turn and the dollar to resume its rally, while others said positioning suggested the dollar’s correction could continue in the meantime.

The greenback’s slide apparently caught many investors short. The latest data from the Commodity Futures Trading Commission on Friday showed currency speculators piled into long dollar bets in the week ended March 10, with net long positions rising to their highest level in four weeks.

Against the yen, the greenback slid as low as 119.29 overnight, its lowest since Feb. 27, trading below 120.00 for the first time in nearly three weeks. It recovered some ground to 120.54 yen, up about 0.4 percent on the day.

“People are still cautiously buying dollar/yen,” Kaneo Ogino, director at Global-info Co in Tokyo, a foreign exchange research firm. “I’m convinced that even after this selloff, the dollar has a solid base against the yen because people are buying on dips.”

Commodity currencies also benefited from the dollar’s slide. The Australian dollar hit an overnight peak of $ 0.7846. It was last down about 0.6 percent at $ 0.7730 but well off a six-year trough of $ 0.7561 set earlier this month.

Central bank meetings in Switzerland and Norway will take centre stage later in the session.

(Editing by Chris Reese and Eric Meijer)